Here’s the Giant Shoe About to Drop on the Economy

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With rising interest rates and expected increases in the Federal debt, at some point in the next ten years, annual interest payments are on pace to exceed the U.S. defense budget.

Janet Yellen’s long-awaited confirmation as the next chair of the Federal Reserve Board Monday makes it nearly inevitable that she will, sooner or later, preside over that increase in interest rates.

When she does, the rising rates will come in the company of generally good news. The Federal Open Market committee has made it clear that rates will only rise when the economy’s recovery from the Great Recession is well under way. But for the federal budget, the news about rising rates is anything but good.

The Federal Government is currently $17.3 trillion in debt, and is projected to continue adding to the national debt every year for the foreseeable future. And when interest rates go up, so does the cost of servicing both new debt and debt that is rolled over in the form of newly-issued Treasury securities.

The likelihood of rates going up in the near future is almost beyond dispute. Yellen’s confirmation was still headline news this morning when Federal Reserve Bank of Boston President Eric Rosengren delivered a speech urging the Fed to be cautious as it dials back its stimulus programs and considers when it should begin tightening up the money supply.

What made Rosengren’s speech particularly interesting, though, was its tone of resignation. Rosengren, who just finished a year’s service on the Federal Open Market Committee, spent 2013 as a vocal supporter of the Fed’s policy of keeping interest rates low and using asset purchases to stimulate the economy. In his last vote as a member of the FOMC in December, Rosengren was the sole dissenter when the committee decided to begin reducing its asset purchases and signaled future interest rate increases.

He may not believe rates should come up any time soon, but in his speech, the Boston Fed president seems to have accepted the fact that his side lost the argument.

Rather than argue against tightening monetary policy, he simply argued, “U.S. policymakers should remove monetary accommodation gradually, to minimize the costs and risks of not returning to full employment more quickly.

That rising interest rates are practically inevitable means the price of servicing the federal debt is about to jump. A study last fall by the bipartisan Committee for a Responsible Federal Budget noted that total interest payments on the federal debt in 2013 were approximately $255 billion. To put that in perspective, the sequester that was the focus of such debate in 2013 and ultimately led to a government shutdown only cost $85.3 billion in its first year.

But that figure is somewhat misleading. The $255 billion is about the same amount the government paid to service its debt in 2006, when the debt outstanding was equal to only 40% of today’s total.

The difference? Low interest rates. Right now, the Treasury pays 0.01 percent on three-month T-bills and 2.98 percent on ten-year notes. The historical average for those two securities are 3.3 percent and 5.2 percent.

According to the CFRB, if interest rates rise as most estimates expect (3-month Treasuries to approximately 4 percent by 2018 and 10-year Treasuries to approximately 5.2 percent) interest payments on the Federal debt will soar to $505 billion in 2018.

A longtime reporter on the intersection of the federal government and the private sector, Rob Garver served as a National Correspondent, based in Washington, D.C., for four years. He has written for ProPublica, The New York Times and other publications.